Friday, November 19, 2010

China Plays Chicken with the Economy

I've written a couple of items on how China is growing, but at the same time has some tricky things to figure out. The biggest issue is how does China keep growing the economy? Previous years count the lucky number as 7: the Chinese government estimates that a 7% annual growth rate is necessary to keep the population happy. The world complains that the RMB is undervalued, which unfairly enables Chinese-made products to cost less than products from other nations in the international market.

The thing is, while economic health is an important issue in most of the developed world, it's perhaps more important in China because it's commonly believed that annual 7% economic growth is the only thing that keeps China's population from mass riots. China has almost no social safety net, despite being a Communist nation (or as many economists might say, due to being a Communist nation, but that becomes less and less an argument as they transition more and more to capitalism). There are a bunch of factors that ensure that China's future long-term success is not a sure shot.

Firstly, relying on the economy to keep people happy and fed is hard because much of the growth just can't be sustainable. You know that things are out of control when normal middle class people start pulling every trick in the book to get on the train before it leaves the station. Like getting a divorce just to be able to qualify to get a second home? Those restrictions were put in place to cool down the real estate market. Instead, it just keeps heating up. What happened to buy low, sell high?

Since the beginning of 2010, the price of sugar has increased 100 percent and the price of garlic ten-fold in some regions of China. Hot pepper rose from 4 yuan ($0.60) a kilogram to 40 yuan in May in Beijing, and the price of potatoes surged 84.8 percent from January to June.

When inflation is going wild like this, people's income is worth significantly less. For a nation that depends on economic health for the happiness of its population, this is a bad thing. The biggest example for me is in the bottles of Minute Maid. I swear that a bottle of Minute Maid orange juice in China was a lot bigger in April than it is now. And it's still the same price.

Thirdly, the wealthier folks are feeling the pressures/risks that arise from income disparity, and are turning to private bodyguards for protection. This trend has been increasing for a few years now. It demonstrates two things: firstly, people don't trust the government to be able to keep order. Secondly, people don't trust their fellow members of society to be nice. That can only entrench the idea of an unstable society.

Since the Chinese government only has the economy at their disposal to keep order peacefully, they're caught between a rock and a hard place. A lot of China's growth has been in real estate, but you can just feel that there's something wrong with this real estate picture. A friend of mine recently invested in a condo with another friend. They plan to flip it in a few years. But they don't want to rent it out to anybody in the meantime because the wear and tear from living in it would decrease the condo's long-term potential value.

Likewise, in Beijing after the 2008 Summer Olympics, there were many buildings that were made for the Olympics, but absolutely empty with no purpose afterwards. The government is investing everywhere, but governments are highly inefficient at allocating capital. So both residential and corporate real estate are skyrocketing, but with no real tenants. It's a ponzi scheme where owners just hope they can sell to another sucker before it all comes crashing down.

Hey, we've seen this movie before, haven't we? The USA kept investing in real estate and even started handing out bad loans so that people could afford to buy homes they couldn't afford, because they incorrectly assumed that prices would always go up, enabling an easy refinancing of loans when necessary. And we know how that movie ended. Actually, no we don't. Maybe we're only in the middle of that movie, and there are more disasters to come.

A just economy is the foundation for a healthy economy. I attended a seminar today put on by the Swedish Chamber of Commerce on business corruption in China. The speakers were comprised of the head of a Scandinavian security consultancy based in Beijing (the guy used to be the head of security for the royal family in Sweden, how cool is that?), and a Swedish lawyer based in Hong Kong. I came away from this seminar with five main points:

If you want to do business in China, you need people on the ground that you can trust. And you can trust local Chinese people to do the job for you, you just need to find the right ones. In fact, hire a security consultancy to do some due diligence for you. Even if the firm, bank, or factory comes highly recommended. Yeah, OK, I was sold very well.

While the central Chinese government is hardcore about stamping out corruption, China's a big country, and Beijing is far away from everywhere else. The stuff that happens on the ground can be horrible, and you can't walk in blind and naive. Imagine being unable to leave for your home country for a business trip or vacation, just because you didn't pay someone a bribe for your business operations. And it doesn't get resolved until 5 months later, despite intercession from your embassies. All because of a small town judge living in a conspiring world.

Guanxi (the power that arises from having strong relationships) does not equal corruption. People give each other gifts and take care of each other because of guanxi, but guanxi is about true friendship. Corruption is when money is passed to get something done that would not have been done without the money. Admittedly, it's sometimes hard to differentiate between the two scientifically or in a court of law. It may be one of those things where only the people who are directly involved can really know and understand what's happening.

You can't brush all of China with one stroke. While there are plenty of stories of corruption and bad things, you can't paint all of China with the colours of just a few experiences. Again, Beijing is far away, and many people and companies are experiencing good success in China. Stereotyping is like driving through a gang fight in LA and thinking that everyone in the USA shoots guns at each other all day long. It's just not true everywhere just because you can cite some examples. But the examples do give you reason to take the risk seriously and prepare for it well.

People aren't afraid of using physical violence to make their point. Especially if everyone stands to gain from the "protection money" (looking at the cops). One business executive was brutally assaulted for just switching suppliers. He felt his old supplier wasn't paying enough attention to quality. So the supplier got some hoodlums to go after him.

The fact that corruption still exists in vast quantity is poison to China's future economic health. Eventually, a business has to decide whether the risks are worth it, and if so, fully commit to investing in the proper things to do things properly. However, point #5 is the most relevant for thinking about what happens if China's economy crashes and is unable to recover.

Maybe, just MAYBE, China's middle class will continue to grow, China will be able to move up the value chain, and China will be able to start developing real heavy duty sustainable consumers. However, if they don't and the house of cards comes crashing down, what will happen? What happened with any extremely upset population throughout history? Revolution. It's a scary thought. In the most extreme case, the Chinese government could implement martial law. I've seen the military out in force before in rural regions where there was risk for unrest; it quiets things down in a hurry. But then the question arises whether it would escalate to civil war.

When China's trying to keep its economy growing at the expense of other nations, it's true that it wants to be #1, it's true that it wants to be king, rather than the servant. But perhaps it's more that they're just scared to death that if they don't keep this economic engine going, they'll see the worst riots in their history. There is no safety net here. The Chinese government can't be flippant and say, "Let them eat cake."

But what about things that are more foundational? What if there's something to change the fundamental aspect of why China believes that economic prosperity is its only weapon against potential unrest? I've never been broke or homeless before. But I've met people who have been in such a destitute state, were able to survive it, and then recover and thrive. What I've learned from these people is that you can't let your self-worth depend on your wealth, success, or happiness. Those are forever effects, not causes. Your sense of life, purpose, and attitude needs to be rooted in something much stronger and long-lasting. For me, that's my faith. For China, that's... what? I think that's the question that China must answer, because if they can't, they might not be able to survive any crash that might come their way. And I'll posit that God is the only final answer that can withstand any test. In my experience, he can change people's hearts for the better too. And judging from the stories of these people I know, that kind of inner strength and hope is the most important thing for surviving a major crisis and then recovering from it.

Can China learn the lesson that money can't buy everything? Or will it continue to play chicken with the economy and just hope that everyone survives?

4 comments:

Officially, China is an atheist state and any current religious organization that exists within the nation are government-sanctioned, meaning that their beliefs have to largely conform with those of the party line. I personally believe that any religion including Christianity at the core is good and this is what present-day China is lacking. If not religion, then a belief to a subscribed ethical code such as Confucianism. If you look at Japan, South Korea, Taiwan (Republic of China), Hong Kong and Singapore, all of these nations are capitalistic in nature and managed to industrialize successfully without having to shed their traditional religious/spiritual beliefs and core values, i.e. Confucianism, Taosim, Buddhism, Shintoism (in the case of Japan). They manage to make these beliefs and value systems relevant to the modern world and this is what China is still struggling with because they basically did away with all of that during the Cultural Revolution. China is essentially going through the same process of industrialization that Taiwan (Republic of China), Hong Kong, South Korea, Japan, and Singapore went through except they don't have the traditional religious/spiritual and core values (Confucianism) to provide them with a foundation to act and conduct business in an ethical manner.

I'd also like to add that Mr. Simpson once told our History 12 class that in order to develop successfully, China must democratize, have an open press and establish the rule of law because you can't have a free market economy operate within an authoritarian state. It just does not work that way. You either need to have one or the other and not both. And the more I look at China, the more I think he is right. There need to be laws and regulations established to regulate the conduct of business within the state. People also need to respect and adhere to these laws as well and understand that nobody (not even the head of state) is above the rule of law because knowing mainland Chinese, they normally pay scant attention to the rules. This is where education comes into play. I hate to say it. But things are generally pretty screwed up in mainland China right now. When you take a populace that is still grappling with the lightning-fast pace of industrialization and trying to fill a spiritual vacuum (money in place of Maoism) in an authoritarian state such as China, it's a recipe for disaster.

Who is PakG1?

I'm a Vancouver Canuck fan now living across the pond in China. My interests include disruption, global trends, Go (also known as Baduk or Weiqi), information asymmetry, games, innovation, languages, reading, skiing, and volunteering.